Op-Ed: The cryptocurrency bubble: It’s not if, but when it bursts
When will the bitcoin speculative bubble burst?
Like all speculative investment euphoria bubbles, there is a time when a herd of investors enamored with huge returns will begin to invest or consider investing in asset classes they don’t fully understand or comprehend. Such is the case with bitcoin, which is the name of the most well-known cryptocurrency and was why the technology we know today as “blockchain” was invented.
Blockchain is the system used to record information to make it difficult or impossible to change, hack or cheat the system. Thus, a blockchain is a digital record of replicated and disseminated transactions that encompasses a complete network of information systems on the blockchain.
What is a cryptocurrency?
A cryptocurrency is a medium of exchange, as is the US dollar or the euro. However, it is digital and uses encryption techniques to control the creation of monetary units and verify the transfer of funds.
Let me start by letting you know that I don’t support bitcoin and have no investment interest in it.
However, many of my readers and clients have become interested in this asset class, so I have decided to discuss the topic in-depth for others to understand it better.
The first thing everyone needs to understand is that all currencies of countries worldwide are backed and supported by the taxing power, fiscal authority of a country, utilizing the rule of law and issued by the nation’s central bank. Until a few years ago, currencies were backed by gold reserves or the so-called “Gold Standard,” which is when a country’s monetary system is backed directly to its value in gold.
On the other hand, cryptocurrencies are not backed by any asset, physical commodity, or precious metal, nor by the faith or credit of any nation. This simple fact means that, should there be a significant or total loss of value of cryptocurrencies, there is no protection. From their creation to their current value, all bitcoin included has been driven by speculative investment.
For much of its history, bitcoin’s current value has been driven primarily by speculative interest.
Let’s look at the most recent bitcoin trades. Bitcoin closed on Aug. 18, 2021, trading at about $44,534.45; however, if we compare the price of bitcoin on June 18, 2014, the closing price was $485.12, a 9,080% return.
On the flip side, let us compare the ICE US Dollar Index, which closed on Aug. 18, 2021, at $93.15, versus Aug. 18, 2014, which closed at $81.58, getting a 14.18% return.
Now, there is also a fundamental difference between dollars and cryptocurrencies. The government does not insure cryptocurrencies as bank deposits in the United States are insured by the FDIC or credit unions with the Public Corporation for the Supervision and Insurance of Puerto Rico Cooperatives (COSSEC, in Spanish).
That means that cryptocurrencies stored online have none of the protections that money deposited in a bank account has. Also, if you hold your cryptocurrency in a digital wallet provided by a company like Coinbase, Binance, Kraken, or Bitfinex, should any of these companies cease operations or suffer a hacker attack, the government will not act and help you get your money back as it could with cash held in banks or credit unions.
However, there are even more signs that it’s not all growth for bitcoin. We note the following when comparing Aug. 18, 2021, versus Aug. 18, 2020:
- Bitcoin Transactions per day: we note that it is down to 257,766, down from 293,281 or -12.11% lower the same period last year;
- Bitcoin Supply: is at $18.79 million, up from $18.46 million a year ago, a feeble increase of only 1.77%;
- Bitcoin Average Difficulty: is down to 15.56 trillion, versus 16.95 trillion a year ago, a reduction of 8.21%;
- Total bitcoin value per day: has risen to 2.363 billion, versus 1.041 billion a year ago, increasing 127.1%;
- Bitcoin Average Cost Per Transaction: has risen to $198.78, versus $41.10 a year ago, an increase of 383.70%;
- Bitcoin’s market capitalization: has risen to $879.50 billion, versus $219.78 billion a year ago, an increase of 300%; and,
- NYSE Bitcoin Index (^NYB): aims to represent the value of (1) bitcoin in dollars; it closed at $46,011.95, versus $11,920.90 a year ago, a growth of 285.97%.
As you can see by the numbers, bitcoin and other cryptocurrency investments have captured a considerable following and a great deal of attention during the current “Bull Market,” which benefits from the increased liquidity in the financial markets and the euphoric following of the herd arising from some market rallies.
These cryptocurrencies and other speculative investments like them have generated enormous attention and price rises in the last year. Just compare the GameStop saga that we talked about at length. As you may recall, the run-up in GameStop (GME) stock was similarly based on pure speculation to a company that was losing money and had no basis to see its stock grow from $4.59 in March 2020 to as high as $347.51 on January 27, 2021, to as close as Aug. 18, 2021, when the stock was at $159. By the time the speculation was over, it had collapsed a hedge fund and lost hundreds of thousands of large and small investors more than $20 billion.
In conclusion, every time someone asks me about bitcoin or cryptocurrency, I tell them the 17th-century tulip bubble story. This was the period in the Dutch golden age when contract prices for some bulbs of the then newly introduced, beautiful, and famous tulips reached extraordinarily high levels, and like all bubbles, it collapsed dramatically in February 1637. The tulip bubble was the first recorded and documented speculative or asset bubble in history.
The tulip bubble is very similar to the cryptocurrency bubble in many ways, being more of an unknown socio-economic phenomenon based on pure fiction. Since then, the acronym “tulip bubble” has been used as a metaphor to denote large economic bubbles when their prices deviate from their intrinsic values, which is the measure of what an asset is worth.
So, for me, the only difference between the tulip bubble and the cryptocurrency bubble is that its speculative euphoria has not yet ended for the cryptocurrency.
And that, my friends, it’s a matter of when it will burst, not if.